3.

2 Costs & Revenue (Questions)

Classifying Costs

Fixed Costs
These are costs that are independent of the sales

volume or productivity of the firm.

Common examples include rent, interest on loans,

salaries, machinery and insurance. These do not change

when output changes. (However, fixed costs can

change over time. A business can have their property

tax, insurance, rent, etc all increase for reasons totally

apart from their level of production).

Variable Costs
These are costs that depend on the output, and will therefore

increase proportional to the increase in output. These include

wages, electricity, raw materials, etc. Added to the fixed costs,

these form the total costs (TC).

Semi-Variable Costs
These are partially fixed and partially variable. An

example is phone bills, which remain constant to a

certain point, and then increase from there.

Direct Costs
Direct costs can be directly associated to a certain unit, and without that unit they are not charged. These

vary depending on the type of firm and their operations.

Indirect Costs
These are also called overheads. They cannot be directly associated with a certain unit, but must still be paid

for all the operations to take place. Therefore, they tend to be divided among all the units. Many fixed costs,

like rent, are indirect costs.

Revenue
Revenue is the total income from the sales of the products, without subtracting costs. It is calculated by:

Total Revenue = Price x Quantity TR = P x Q R=PxQ

=
=
Total Revenue = Average Revenue x Quantity TR = AR x Q R=PxQ
=
=

This can also come from other sources, such as subsidies, grants, donations, fund-raising, sponsorship,

interest from the bank, dividends and the sale of assets.

Contribution to Fixed Costs

Once direct costs and variable costs are taken away from the selling price, the remaining amount is used to

cover fixed and indirect costs.

Calculating the contribution ensures that the fixed costs are accounted for before the profit can be calculated.

Therefore, the business may improve their profits by increasing sales, lowering variable costs or fixed costs.

The contribution can also act as a measure of which products are more important to the business.
 1.Calculating Business Costs in a Table
OUTPUT TFC($) TVC ($) TC($) AC($) AFC ($) AVC ($)
(Units)
0 2000 - - -
100 500
200 1000
300 3450
400 3800
500 9.00
600 9.70

Total Costs, Total Fixed costs, and Total Variable Costs

Total costs (TC) are the sum of Total Fixed Costs (TFC) plus Total Variable Costs (TVC):

Total Cost = Total Fixed Cost + Total Variable Cost TC = TFC + TVC
Total Cost = Average Cost x Quantity TC = AC x Q

Total fixed costs:

the total costs incurred by the firm for variable inputs that are held fixed in the short-run. If the period under
consideration is the long-run, then there are no fixed costs because all inputs in the long run are variable and
therefore, the cost associated with those inputs are also variable.

Total variable costs

TVC are the total costs incurred for variable inputs. The TVC gets higher as a firm sells more units of product.
Average Variable Costs might get lower as TVC increases if the firm can manage specialization or purchasing
economies of scale.

Start Up Costs Ongoing Costs

Average Costs: Total (ATC), Fixed (AFC) & Variable (AVC)
For the 3 examples below, the following data will be used each time

Total Cost = $100 Quantity sold = 25 units Fixed Cost = $75 Variable Cost = $1/unit

Average total cost (ATC or simply AC)

ATC of the firm is the total cost divided by quantity. Average total costs can also be expressed as the sum of AFC
and AVC (2nd example)

Method 1 Method 2

ATC = TC / Q OR ATC = AFC + AVC

= =

Average fixed cost (AFC)

AFC of the firm is the total fixed cost divided by quantity or average fixed cost minus direct costs.

Method 1 Method 2

AFC = TFC / Q OR AFC = ATC - AVC

= =

Average variable cost (AVC)

AVC of the firm is the total variable cost divided by quantity. OR by taking the average total cost then
subtracting the average fixed cost.

Method 1 Method 2

AVC = TVC / Q OR AVC = ATC - AFC

= =
= =
In deciding how many units to produce the most important variable is the marginal cost – the increase (decrease)
in total costs from increasing (decreasing) output.
 2. Practice Question
You try it now!! For the 3 examples below, the following data will be used each time

Total Cost = $1500 Quantity sold = 150 units Fixed Cost = 450 Variable Cost = $7/unit

Average total cost (ATC or simply AC)

ATC of the firm is the total cost divided by quantity. Average total costs can also be expressed as the sum of AFC
and AVC (2nd example)

Method 1 Method 2

ATC = TC / Q OR ATC = AFC + AVC

= =
=
=

Average fixed cost (AFC)

AFC of the firm is the total fixed cost divided by quantity or average fixed cost minus direct costs.

Method 1 Method 2

AFC = TFC / Q OR AFC = ATC - AVC

= =
= =

Average variable cost (AVC)

AVC of the firm is the total variable cost divided by quantity. OR by taking the average total cost then
subtracting the average fixed cost.

Method 1 Method 2

AVC = TVC / Q OR AVC = ATC - AFC

= =
=
In deciding how many units to produce the most important variable is the marginal cost – the increase (decrease)
in total costs from increasing (decreasing) output.
 3.Practice Question - Paragraph form
Robert decides to start a small side business selling protein drinks. He spends $100/month on
marketing expenses and has no other overhead. Each drink requires protein powder ($0.65),
fruit ($0.40) and packaging ($0.16). He charges $4.00 per drink. If he sells 200 per month,

What is his total revenue?

TR = PxQ
=
=

What is the contribution margin?

CM = P - AVC
=
=
=

What is the monthly total cost?

TC = TFC + TVC
= 100 + (VC x Q)
=
=
=
What is his monthly profit?
Profit = TR - TC
= (P x Q) - (TFC + TVC)
=
=

What is the Break Even Point (Preview to Unit 3.3)

BEP = FC / CM
=
Safety Margin
SM = Q - BEP
=
 4.Practice Question - Management Decision
A company makes a product and has the following attributes: Direct cost of $3/unit. Overhead
of $4000 per month. Price for customers is $8/unit. Their monthly demand is 1300 units.

1. What is the contribution per unit?

Contribution = ___ - ____
= $___ - $____
= $___
2. What is the monthly total variable cost?
TVC = _____ x _____
= $___/unit x _____ units
=$______
3. What is the monthly total cost?
TC = _______ + ______
= $______ + $______
= $________
4. What is the average fixed cost? Show 2 ways of calculating this.

AFC = TFC/Q AFC = AC - AVC

= $_______ / ______ units = ($______/ _____ units) - $____
= $_______ = $_____ - $____
= $_____

5. What is the monthly profit (or loss)?

Profit = _____ - _____
= _____ - (_____ + ______)
= ($___/unit x _______ units) - $________
= $_______ - $_______
= $_______
 6. If they spend an extra $2000 on marketing to increase brand awareness and sell
300 additional units as a results, what is the impact on their profitability?
Profit =
=

7. If they spend an extra $1700 a month on marketing to improve brand image and
now charge $9.50 per unit and still sell a quantity of 1300, what is the impact on
their profitability? (as compared to the original information)
Profit =

8. If the company decides to pay their employees a commission of $0.25 per unit and
sales volume increases to 1500 units a month, what is the impact on their
profitability? (As compared to the original information)
Profit =

5. Calculating Business Costs & Graphing Skills

OUTPUT (Units) TFC($) TVC ($) TC($) AC($) AFC ($) AVC ($) Revenue (P=8)
0 1200 - - -
100 300
200 600
300 2040
400 2400
500 5.6
600 1200 5.7
1. Chart #1: graph the TFC, TVC, TC and Revenue lines. Use a ruler and colours (optional)
2. Label each line and axis properly. (Hint - price vertical axis, quantity horizontal axis)
3. Chart #2 Graph the AC, AFC and AVC curves and mark the optimal level of output on the diagram. Label each line and axis properly.
4. Explain why a cost curve has that shape. Why a business might not be able to produce at the optimal level of output.
 Unit 3.2 Graphing Skills
Name __________________

From #5 on the sheet above, graph the TFC, TVC, TC and Revenue lines. Use a ruler and colours (optional)
Label each line and axis properly. (Hint - price vertical axis, quantity horizontal axis)

Graph the AC, AFC and AVC curves and mark the optimal level of output on the diagram. Label each line and axis properly.
6. Practice Question - Table
OUTPUT (Units) TFC($) TVC ($) TC($) AC($) AFC ($) AVC ($)
0 - - -
100 4,000
200 37
300 24,900
400 67.50
500 15,000 38
600 42,000

7. Challenge Practice Question - With Marketing Theory

A company makes a product and has the following attributes: Direct cost of $12/unit. Overhead of $4000 per
month. Price for customers is $20/unit. Their monthly demand is 2000 units.
1. What is the contribution per unit?
CM = 20 - 12
=8
2. What is the monthly total variable cost?
TVC = VC x Q
= 12/unit x 2000 units
= 24,000
3. What is the monthly total cost?
TC = TVC + TFC
= 24,000 + 4000
= 28,000
4. What is the average fixed cost? Show 2 ways of calculating this.
AFC = TFC / Q
= 4000 / 2000
=2
5. What is the monthly profit (or loss)?
Profit = TR - TC
= (2000 x 20) - 28,000
= 40,000 - 28,000
= 12,000

6. If they spend an extra $1800 on marketing to increase brand awareness and sell 300 additional
units as a result, what is the impact on their profitability?
Profit = TR - TC
= (2300 x 20) - (TVC + TFC)
= (46,000) - (2300 x 12 + 5800)
= (46,000) - 33,400
= 12,600
 7. If they spend an extra $4100 a month on marketing to improve brand image and now charge $22
per unit and still sell a quantity of 2000, what is the impact on their profitability? (as compared to
the original information)

8. If the company decides to pay their employees a commission of $1.50 per unit and sales volume
increases to 2300 units a month, what is the impact on their profitability? (As compared to the
original information)

8. Multiple Products & Contribution

Consider the cost and contribution for a local concession stand.
(Mark Up % = contribution/VC)
Burger example (1.60 = 4.00/2.50)
PRODUCT Burger Pizza Sub Fries Chips Pop Ice Cream
Avg Price for 6.50 4.00 6.00 3.50 1.50 2.50
consumer
Avg Variable 2.50 1.75 2.20 0.40 0.50
Cost
Unit 4.00 3.80 2.60 1.10
Contribution
Mark Up % 160% 173% 289% 150%
Comment on the importance of unit contribution vs mark-up to a business.